By Michael Aneiro

Barclays this week downgrades the entire electric sector of the U.S. high-grade corporate bond market to underweight, saying it sees long-term challenges to electric utilities from solar energy, and that the electric sector of the bond market isn’t pricing in these challenges right now. It’s a noteworthy downgrade since electric utilities which make up nearly 7.5% of Barclays’ U.S. Corporate Index by market value. From Barclays credit strategy team:

Electric utilities… are seen by many investors as a sturdy and defensive subset of the investment grade universe. Over the next few years, however, we believe that a confluence of declining cost trends in distributed solar photovoltaic (PV) power generation and residential-scale power storage is likely to disrupt the status quo. Based on our analysis, the cost of solar + storage for residential consumers of electricity is already competitive with the price of utility grid power in Hawaii. Of the other major markets, California could follow in 2017, New York and Arizona in 2018, and many other states soon after.

In the 100+ year history of the electric utility industry, there has never before been a truly cost-competitive substitute available for grid power. We believe that solar + storage could reconfigure the organization and regulation of the electric power business over the coming decade. We see near-term risks to credit from regulators and utilities falling behind the solar + storage adoption curve and long-term risks from a comprehensive re-imagining of the role utilities play in providing electric power.

Valuations suggest credit investors are depending on the “regulatory compact,” (whereby the monopoly utility agrees to invest in assets to service customers in return for prices that are set to allow them a reasonable return) to give sufficient protection from industry changes. While the regulator/utility construct has usually resulted in low-risk returns to credit in the past, technological change creates precisely the environment where slower-moving incumbents and their regulators can fall behind the curve, risking credit volatility, or disrupt the regulatory compact, possibly leading to unexpected losses for bondholders. Investors may be also wary of optimism about solar power, given a recent history of losses in that industry. We believe that sector spreads should be wider to compensate for the potential risk of regulator missteps and/or a permanent change in the utility business model.

Whether because of biases or analytical complexity, the market (and its constituent prognosticators) has tended to be late in pricing technology-driven shifts, particularly in industries that have had stable operating models (such as telcos and airlines).

Barclays says it sees “a rare opportunity for investors to express views about a potential for a major change at low cost and with good liquidity,” and recommends investors who can do so should underweight the electric sector versus the broader U.S. Corporate index, and rotate out of bonds issued by utilities in areas “where solar + storage is closer to competitiveness” into bonds issued by companies “where solar + storage grid parity are more distant.”

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MAY 24, 2014 11:48 A.M.

bud U. wrote:

Insaaaaaaane!!!!

MAY 24, 2014 1:17 P.M.

Rob Harmon wrote:

The utility sector has an alternative to the lost revenues and lost investment opportunity associated with distributed solar (net metering) and traditional energy efficiency. One alternative can be found here: http://www.meetscoalition.org/

JUNE 1, 2014 2:07 P.M.

Chainsaw wrote:

So the best investment advice is to pull your money out of areas that are successfully implementing solar power (which are not coincidentally desirable areas in a lot of other ways as well) and invest in the more backwards areas. Sound investment advice, I suppose...

"“a rare opportunity for investors to express views about a potential for a major change at low cost". Or dogwhistle, perhaps.

JUNE 24, 2014 10:44 A.M.

swampwiz wrote:

It would seem that if solar truly reached grid parity, then it would make sense for utilities to build solar farms. Perhaps this would mean that old fossil & nuclear fueled power plants would become obsolete, which would have an also deleterious effect on their finances.

The price of electricity from the grid today is somewhere around double what you would need to pay in distributed generation solar, if your own. If you're in California within a couple of weeks there will be a calculator at http://www.solarpayoff.com that makes this point in unmistakable terms using current pricing for DG solar, Google Earth GIS, and the PVWatts calculator at the National Renewable Energy Lab. However, it is true under netmetering that you are still using the grid as a "battery" and that the utilities and the Koch Brothers are doing everything in their power to charge DG solar adopter to use their grid which is, indeed, very expensive. Our models don't yet price in leaving the grid with your own batteries. Whether that's socially a good idea is another question. There are probably good reasons to remain interconnected at some level.

But here's the question. if the markets are moving away from utility bonds, are the banks yet willing to finance DG solar ownership (as opposed to the highly exploitive something-for-nothing solar leases)? When banks start thinking about DG solar which lasts somewhere around 30 years the way they think about financing a car which lasts 10-15, maybe we'll see the solar take-off that would significantly disrupt the business model of the utilities.

Why is it they are allowed to own the grid anyway??

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The whole utilities sector in Brazil has been messed up by the government for, at least, 4 years (http://www.trusera.com/q48/). That cause a huge distortion in the market and now everyone is paying the price.

Amey Stone is Barron’s Income Investing blogger and Current Yield columnist. She was formerly a managing editor at CBS MoneyWatch, MSN Money and AOL DailyFinance. Her responsibilities included overseeing market coverage and personal finance topics. Prior to those roles, she was a senior writer at BusinessWeek where she authored the Street Wise column online and contributed to the magazine’s Inside Wall Street column. Topics covered included economics, corporate finance, Fed policy, municipal bonds, mutual funds and dividend investing. She co-authored King of Capital, a biography of Citigroup Chairman Sandy Weill. She is a graduate of Yale University and Columbia University’s Graduate School of Journalism.